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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number 0-22025

Aastrom Biosciences, Inc.

24 Frank Lloyd Wright Drive

Registrant’s telephone number, including area code: (734) 930-5555

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

      Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 75 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).     Yes þ          No o

      The approximate aggregate market value of the registrant’s Common Stock, no par value (“Common Stock”), held by non-affiliates of the registrant (based on the closing sales price of the Common Stock as reported on the Nasdaq SmallCap Market) on December 31, 2003 was approximately $94 million. This computation excludes shares of Common Stock held by directors, officers and each person who holds 5% or more of the outstanding shares of Common Stock, since such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for other purposes.

      As of August 31, 2004, 83,076,168 shares of Common Stock, no par value, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

AASTROM BIOSCIENCES, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

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      Except for the historical information presented, the matters discussed in this Report, including our product development and commercialization goals and expectations, revenue expectations, potential market opportunities, our plans and anticipated results of clinical development activities and the potential advantage of our products and product candidates under development, include forward-looking statements that involve risks and uncertainties. Our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed under the caption “Business Risks” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unless the context requires otherwise, references to “we,” “us,” “our” and “Aastrom” refer to Aastrom Biosciences, Inc.

PART I

      We are a late-stage development company focused on the development of processes and products for the ex vivo production and sale of human cell products for use in cell therapy and regenerative medicine. Our pre-clinical and clinical product development programs utilize adult bone marrow stem and progenitor cells for forming solid tissues such as bone, vascular tissue, cartilage, and blood and immune system cells.

      Cell therapy is the use of living cells in the treatment of medical disorders. These cells can either be used in conjunction with, or as a replacement for, traditional therapies. Cell therapy began with simple, but very effective, blood and platelet transfusions, expanding later to include specialized procedures including hematopoietic stem cell transplants obtained from the marrow or from the blood stream after stem cell mobilization. In hematopoietic procedures, stem cells are transplanted into patients to restore blood and immune system function that is damaged or destroyed by aggressive chemotherapy and/or radiation therapy used to treat the cancer. In immunologic cell therapy, T-cells and dendritic cells are administered to stimulate an immune response in patients with various forms of cancers and infectious diseases, such as viral infections. In recent years, pre-clinical and clinical observations appear to extend the potential use of bone marrow-derived stem cells to regenerate multiple tissues including bone, blood vessels, cartilage, cardiac tissue, and nerves.

      While these forms of cell therapy are emerging as potential new treatment options for several diseases and medical disorders, the success of cellular therapy is based, in part, on the need for care providers to be able to access therapeutic quantities of biologically active cells necessary for patient treatment, cost-effectively and in compliance with regulatory requirements. Our patented AastromReplicell® System and single-pass perfusion technology are intended to enable the manufacturing of patient specific cell products for clinical use.

      In the expanding field of cell therapy, we develop proprietary Prescription Cell Products (PCP) for the regenerative repair of damaged human tissues and other medical disorders, the first of which is now in the clinical stage. Our lead PCP products are Tissue Repair Cells (TRCs), which are a unique mixture of bone marrow-derived stem and progenitor cells, produced ex vivo. In previous multi-center clinical trials involving over 160 patients, our TRCs have been demonstrated to be safe and reliable, and to regenerate certain normal healthy human tissues.

      We have also developed our proprietary AastromReplicell System, which is a patented, integrated system of instrumentation and single-use consumable kits for the commercial production of human cells. The AastromReplicell System was developed to provide a manufacturing platform for our proprietary cell products, such as our TRCs. The AastromReplicell System technology has recently been expanded for the production of dendritic cells and dendritic cell vaccines, and is the basis of our Cell Production Products (CPP) business. The clinical use of dendritic cell vaccines is minimal at this time, and as such the market is only just developing. We are currently exploring the market for our CPP dendritic cell vaccine products in the European Union (EU) and in the United States by targeting academic and other third party therapeutic cell developers requiring automated cell production with GMP compliance.

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      Our commercial production pathway for our Prescription Cell Products is enabled through the AastromReplicell System platform. This proprietary and automated clinical cell production system combines patented GMP-compliant automated cell production with patented “single-pass perfusion.” Single-pass perfusion is our technology for growing large quantities of highly robust human cells outside the body. These cells include adult stem and progenitor cell mixtures — cells required for forming solid tissues such as bone, vascular tissue, cartilage, and blood and immune system cells.

      Stem cells are human cells that have the capability to form many or all of an individual’s tissues and organs. Our PCP cell therapy programs currently utilize bone marrow-derived stem cells, a class of adult stem cells that is found in every individual’s bone marrow. Access to adult stem cells is obtained through a recognized procedure, without controversy, and these cells have successfully grown to the increased number of cells required for certain clinical applications, using the patented technology embodied in the AastromReplicell System. Our programs have used bone marrow, cord blood and blood cells as starting sources of cells. As such, federal support or other factors relating to embryonic stem cell research have no direct impact on our current product programs.

      Our primary business model utilizes patented core technology and processes for the manufacturing and distribution of TRC cell products for use in multiple medical markets. Initially, we will pursue TRCs for the following two therapeutic areas:

	•	Local bone regeneration in fractures, spinal fusion and jaw bone reconstruction for dental implants
	•	Vascular (blood vessel) regeneration in limb ischemia resulting from diabetes and other diseases

      In the future, we may develop, and/or support third party development of TRC products for other areas such as cartilage regeneration and cardiac tissue regeneration.

      In the EU, our business and marketing activities are directed through Zellera AG, our wholly-owned subsidiary located in Berlin, Germany

Prescription Cell Products

      We are leveraging our ex vivo cell production technology for a growing Prescription Cell Product pipeline by focusing on our Tissue Repair Cells (TRCs) for stem cell-derived tissue repair and regeneration.

      The clinical trial direction of our development effort has been influenced by observations that our bone marrow cell products (TRCs) may be suitable as a treatment for bone and vascular regeneration, each of which may represent a substantial market opportunity. In reviewing the pre-clinical and clinical data for our bone marrow cell products in various Aastrom-supported trials and research, we have noted that the cells produced contain a substantial increase in the cell types that can generate connective tissues including bone and cartilage. In addition, our bone marrow cell product has been given to one patient, on a compassionate-use basis approved by the FDA, with a congenital genetic defect (hypophosphatasia) resulting in a lethal condition of abnormal bone and cartilage formation. The results of this compassionate-use treatment, now published in the Journal of Bone and Mineral Research, demonstrated bone formation in the child.

      Using the AastromReplicell System, TRCs are grown from a small sample of a patient’s bone marrow. Once administered back to the patient, the cells are intended to generate normal healthy tissues. The primary TRC application we are initially pursuing is bone grafting (large bone fractures, spine fusions or jaw bone reconstruction). In August 2003, the FDA approved our Investigational New Drug (IND) application to begin a multi-center Phase I/II clinical trial for bone grafting in severe leg fractures. Our bone grafting clinical trials have recently been initiated in the U.S. and EU for the treatment of tibial non-union fractures, and we expect to announce additional clinical sites for this application. The initiation of the EU clinical studies for jawbone reconstruction needed for dental implants are pending the finalization of applicable cell production licensing requirements. Once sufficient data is obtained to show the safety and bone-forming

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      Under normal circumstances, bone has the ability to maintain its integrity and repair itself when fractured or damaged, due to its capacity to regenerate. Bone grafting is the procedure of locally applying cells or other material to a bone site to either build or repair needed bone tissue when the clinical situation is such that the natural bone generation process is either too slow or unable to occur. Through scientific advances, it is now widely known that bone grafting can accelerate the regenerative process.

      There are different approaches to bone graft procedures, and each carries with it certain disadvantages. Traditionally, autograft material is surgically taken from the patient’s iliac crest (hip bone) and implanted where it is needed. Sometimes “extenders” are added to this material. There are a number of issues with this autograft procedure, including:

	•	Potential infection at the bone harvest site
	•	Very painful harvest procedure and painful after-effects at the collection site
	•	Chronic pain at the harvest site
	•	Limited supply of autograft material
	•	Additional time in surgery to collect the autograft material and additional time in the hospital to recover

      As a substitute to traditional autograft, allograft, synthetic, and osteoinductive (e.g. bone morphogenic proteins) materials have recently been introduced to address some of these market issues, and are now included in approximately 50% of bone graft procedures in the U.S. However, some of these substitute materials have not been able to produce the same level of clinical efficacy as traditional autograft (e.g. the tempo of formation and the quality of bone), and their use has some other limitations. Additionally, the matrix products (allograft and synthetics) are almost always combined with some biological material, either as an extender of autograft material, in combination with blood or plasma material, or with bone marrow (typically less than 100 ml).

      Our TRCs are being developed as an alternative to the autograft harvest process. First, a physician collects a small starting sample of a patient’s bone marrow with a needle aspiration in a simple outpatient procedure., Then our TRCs are produced in the AastromReplicell System in about 12 days. The TRCs, containing an expanded amount of bone-forming stem and progenitor cells, are mixed with a matrix (allograft or synthetic), and may provide a viable alternative to autograft without the painful after-effects. The total served market for such a product is believed to be more than 1 million procedures annually in the U.S., EU and Japan.

      Additionally, published results from other clinical studies have suggested that large volumes of a patient’s own bone marrow may be concentrated and injected into the vascular tissue area of patients with limb ischemia. Degenerated vascular tissue has a high occurrence in diabetic patients, and can result in immobility, severe ulcerations, and amputation. Bone marrow cells may rebuild this vascular tissue and offer therapeutic benefit; therefore, we are pursuing research to explore the capability of TRCs for vascular regeneration.

      We also believe that the stem and progenitor cell components of our TRCs may be useful for other medical indications, including the regeneration of cardiac tissue and cartilage.

Cell Production Products

      Our Cell Production Products (CPP) operation seeks to market and sell the AastromReplicell System and DC-I (dendritic cells for fusion and transfection), DCV-I (complex antigen-loaded dendritic cells) and DCV-II (peptide-loaded dendritic cells) cell production kits to academic researchers and companies that are developing dendritic cell-based cancer vaccines. We expect that the recent collaborations with users of these products may generate very modest amounts of revenues at irregular intervals, although we are not yet able to project the market size, potential revenues or revenue growth for these products. The EU has recently issued

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Aastrom’s Proprietary Core Technologies

      Our technology platform consists of two components: (i) proprietary processes, “single-pass perfusion”, and culture devices to enable certain types of stem cells and other types of human cells to be produced with superior biological capabilities as compared with standard cell culture approaches, and (ii) the AastromReplicell System, a clinical cell production platform that is designed to standardize and enable an effective GMP-compliant commercialization pathway for bringing therapeutic cell production to medical practice. The AastromReplicell System consists of an instrumentation platform, to be integrated within the hospital or other centralized facilities, that can operate a variety of single-use cell production kits that are specific to the desired medical application. Through this product configuration, we intend either to directly provide cells for therapeutic use, or to enable customers or potential collaborators with the capability to produce cells for therapeutic applications through sale of the AastromReplicell System product line and cell therapy products. This approach is intended to provide a product pathway for each cell therapy that is equivalent to a biological product including regulatory approval, reimbursement, marketing and pricing. We believe that the product design of the AastromReplicell System will allow us to develop additional cell therapy products to provide standardization for a number of emerging cell therapies being developed by other researchers.

      We have developed proprietary processes and patented technologies for ex vivo production of therapeutic stem and progenitor cells as well as other key cells found in human bone marrow. This proprietary process is called “single-pass perfusion” and provides a cell culture environment that attempts to mimic the biology and physiology of natural bone marrow outside of the body. This process enables the production of stem and early- and late-stage progenitor cells needed for an effective bone marrow stem cell therapy procedure. When this process is applied to other cell types, the resulting cell product appears to have enhanced biologic function as compared to cells produced through standard static culture processes. In pre-clinical studies performed at Aastrom, T-cells produced using our proprietary processes appear to have a significantly higher replicative capability. Further, dendritic cells produced using this process appear to have an enhanced ability to present antigen to the immune system. We believe that these benefits can improve the overall clinical effectiveness of these procedures.

      Growth factors can be added to stimulate specific cell lineages to grow cells, or to increase cell growth, to meet a particular therapeutic objective. We believe the stem cell growth process can best be completed with little or no additional stem cell selection or purification procedures. This stem cell replication process can also enable or augment the genetic modification of cells by providing the cell division step needed for new genes to integrate into the stem cell DNA. Other currently available cell culture methods tend to result in a loss of stem cells, either through death or through differentiation into mature cells. When compared with cells grown using standard cell culture techniques, the perfusion approach enables stem cells to grow, and improves the biological features of other types of human cells as well. We have exclusive rights to several issued U.S. patents that cover these processes and cell compositions.

      We have developed a proprietary cell culture chamber to implement our process technology. The culture chamber can produce cells on a clinical-scale and allows for recovery of the cells for therapeutic use. Our pre-clinical and clinical data indicate that our cell culture chamber may be used for growing various types of human therapeutic cells, such as stem cells, T-cells and dendritic cells used for immunotherapies, chondrocytes for cartilage replacement, and mesenchymal cells for bone and cartilage replacement. We hold exclusive rights to issued U.S. patents and additional applications for our cell culture chamber device technology.

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      The AastromReplicell System is our proprietary clinical-scale cell production platform to enable the large scale ex vivo production of a variety of therapeutic cells at healthcare facilities, independent laboratories, transplant centers, blood banks, and centralized cell production facilities. It has been designed to implement our stem cell growth process as well as processes for the production of certain other cell types. The AastromReplicell System is comprised of several components, including microprocessor-controlled instruments and single-use cell production kits such as the TRC-I (for the production of our TRC cell products), DC-I, DCV-I and DCV-II kits (for the production of cells used in our CPP operation for sale to third parties). The single-use cell production kits include an AastromReplicell System Cell Cassette cartridge containing our proprietary cell culture chamber, supply and waste reservoirs, and harvest bag along with process specific software which provides the cell production processing parameters to the AastromReplicell System instruments. The microprocessor-controlled instruments include the AastromReplicell System Incubator which controls the culture conditions for the production of cells within the Cell Cassette, and the AastromReplicell System Processor which automates the procedure sequences such as the inoculation of cells into, and harvesting of the cells from, the Cell Cassette. The AastromReplicell System Manager provides user interface software that monitors the cell production process in multiple Incubators, records relevant process variables and operator actions, and automatically generates cell production batch records.

      The AastromReplicell System is designed to be operated with minimal operator activity by a qualified cell production or cell processing technician to implement clinical-scale cell production. The endpoint of the AastromReplicell System process is a blood-bag containing the specific cell product. The control and documentation features of the AastromReplicell System have been designed to meet GMP requirements for the production of cells for clinical use. The System can be scaled-up producing simultaneous multiple independent cell batches and is suitable for installation in a regional or centralized cell production facility. This is intended to provide a product pathway for each cell therapy that is similar to a biological product including regulatory approval, reimbursement, marketing and pricing. We believe that the design of the AastromReplicell System may allow us to develop additional cell production kits to provide a commercialization pathway for a number of emerging cell therapies being developed by other researchers.

      The typical industry approach to growing human cells has largely used manual research laboratory methods, requiring substantial time and technical expertise. The AastromReplicell System is designed to provide closed-system, automated cell production capabilities in compliance with regulatory standards, with high process reliability and reduced requirements for specialized facilities and staffing.

Product Development

      Our initial development efforts were focused on the development of the SC-I kit for the production of bone marrow stem cells for use in bone marrow transplantation. A decreased market opportunity for the SC-I product led to the discontinuance of further product development in this area. Our current product development efforts are focused on the development of bone marrow-derived stem and progenitor cells — Tissue Repair Cells (TRCs) — for use in orthopedic indications (bone grafting, spine fusion and jaw bone reconstruction) and for use in vascular system regeneration. These cells and processes are very similar to those produced with the SC-I process which have been introduced into human patients in previous trials. (See “Clinical Development.”)Clinical trials are underway to demonstrate bone formation in patients with large bone fractures, and clinical protocols are in development for spine fusions and jaw bone reconstruction, and for treating limb ischemia resulting from peripheral vascular disease. All of these products use Aastrom’s proprietary process and device technologies. We believe that additional products may be developed for use in a variety of other emerging cell therapies.

      Our research programs are currently developing new variations of TRCs that are intended to improve either the functionality for certain clinical indications, improve storage and shelf life, or to decrease the cost of the manufacturing of the TRC products. Programs are also exploring the capability of TRCs to generate different types of human tissues, such as bone, vascular, cartilage and cardiac tissues.

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      The AastromReplicell System has the potential to supplant current manual cell culture methods to produce therapeutic quantities of cell types such as T-cells, dendritic cells, cell-based cancer vaccines, chondrocytes, mesenchymal stem cells, keratinocytes and neuronal cells. For example, Aastrom developed the DC-I, DCV-I, and DCV-II kits for dendritic cell production. Other than a limited application of chondrocyte therapy, novel cell therapies are still in early stages of development by third parties, and such other cell therapies may not be successfully developed. Potential advantages of the AastromReplicell System in these therapies may include: (i) reducing labor and capital costs; (ii) enhancing process reliability; (iii) automating quality assurance and process record keeping; (iv) reducing the need for specialized, environmentally controlled facilities; (v) providing greater accessibility of these procedures to care providers and patients; and, (vi) providing a more biologically active cell product.

      Modification of such processes and application of our products to the expansion of other cell types will require additional development of specialized cell culture capabilities that may need to be incorporated within our existing product platform. Such modifications may require us to raise substantial additional funds, or to seek additional collaborative partners, or both. We may not be able to successfully modify or develop existing or future products to enable such additional cell production processes. See “Clinical Development” and “Business Risks.”

      Research and development expenses for the fiscal years ended June 30, 2002, 2003 and 2004 were $5,428,000, $5,647,000 and $6,289,000, respectively.

Clinical Development

      Currently, our clinical trial direction is focused on the utilization of our TRCs in the areas of bone regeneration and vascular regeneration in limb ischemia resulting from diabetes and other diseases. Both of these therapeutic areas have substantial market opportunities. Our current studies were also influenced by the limited scope of hematopoietic stem cell transplantation.

      In reviewing the pre-clinical and clinical data for our TRCs a substantial increase in the mesenchymal or stromal stem and progenitor cell content was observed. Mesenchymal stromal cells are integral for bone marrow to generate non-hematopoietic tissues such as bone and cartilage. Our TRCs have been administered to one patient under a compassionate use request approved by the FDA, who had a congenital bone disease called hypophosphatasia, which results in a typically lethal condition of abnormal bone and cartilage formation. This compassionate use treatment, now published in the Journal of Bone and Mineral Research (April 2003, Vol. 18, page 264), resulted in long-term systemic bone formation in the child. Subsequently, we demonstrated in the laboratory, and in mice, that our TRC product is capable of forming bone lineage tissue.

      Based on these and other pre-clinical and clinical observations, we are currently enrolling patients in U.S. and EU clinical trials for bone regeneration in patients with severe limb fractures. The U.S. trial is being conducted under an FDA approved Investigational New Drug (IND) application, including up to three participating centers and as many as 20 patients. The EU trials are now underway at centers in Spain and Germany, under Ethical Committee approvals. We are developing a protocol and an IND submission for a clinical trial to evaluate TRCs in spine fusions. We expect to have clinical result data from the first five treatments in Spain during the quarter ended December 31, 2004. We are also planning to evaluate TRCs to augment jaw bone reconstruction as a method to improve the well-being of patients needing dental implants, and intend to initiate these studies and provide proof of concept during fiscal year 2005 in the EU.

      In addition to bone and hematopoietic tissues, TRCs have been demonstrated in the laboratory to contain the stem and progenitor cells capable of forming vascular tissue or blood vessel growth. Based on clinical observations of the efficacy obtained using large volumes of unexpanded bone marrow cells, we are developing clinical protocols that will evaluate our TRCs for the treatment of limb ischemia, such as occurs in diabetes and other peripheral vascular diseases.

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      The preliminary results of our pre-pivotal trials may not be indicative of results that will be obtained from subsequent patients in the trials or from more extensive trials. Further, our pre-pivotal or pivotal trials may not be successful, and we may not be able to obtain the required biologic license application (BLA) registration or required foreign regulatory approvals for the AastromReplicell System in a timely fashion, or at all. See “Business Risks.”

      The AastromReplicell System, and certain cell products produced using our system, have been evaluated in multi-site clinical trials in the U.S. under an Investigational Device Exemption (IDE) from the FDA.

      Results from these studies demonstrated the ability of the AastromReplicell System to safely and reliably produce stem and progenitor cells (called “SC-I cells”) that engraft and restore blood system function in breast cancer patients who had undergone very aggressive chemotherapy. Further, the small volume aspirate, along with a purging of contaminated tumor cells during the stem cell production, indicated a way to offer patients a transplant with a lower risk of receiving back tumor cells.

      Based on positive results from the feasibility stage trials, we had initiated a randomized Phase III U.S. clinical trial evaluating the SC-I cells produced with the AastromReplicell System to compliment traditional therapies by augmenting stem cells collected from a single Peripheral Blood Stem Cell (PBSC) apheresis procedure. The objectives of this study were to demonstrate that an optimal hematopoietic recovery could be achieved using the SC-I cells with a sub-optimal PBSC dose that otherwise would not provide this desired outcome.

      However, during the course of the Phase III clinical trial of the SC-I cells, medical developments occurred that have influenced our strategy. These developments included:

	•	The demonstration that high-dose cytotoxic therapy requiring stem cell support did not result in increased survival benefit for patients with carcinoma of the breast compared with standard, less toxic chemotherapy, thus eliminating this medical approach
	•	The demonstration that bone marrow stem cells collected from the PBSC after mobilization by cytokine(s) and/or chemotherapy resulted in more rapid hematopoietic engraftment compared to stem cells collected directly from the bone marrow
	•	The demonstration that only a fraction of patients would be unable to be successfully mobilized for the collection of PBSC using a combination of chemotherapy with augmented dose hematopoietic cytokines
	•	The demonstration that dose-dense chemotherapy followed by cytokine supported hematopoietic recovery may be an alternative to PBSC transplantation for patients with carcinoma of the breast
	•	A change in the policy of the FDA that the AastromReplicell System cell products will now require a Biologics License Application (BLA) for product registration, which was not originally expected or planned

The results of these medical market developments substantially reduced the ability to accrue patients in the Phase III trial we had started. Further, these observations indicated to us that the market value of the product studied by the current clinical hematopoietic studies was becoming markedly constrained and much reduced from estimates performed before trial initiation. Given the limited market opportunity, the newly added regulatory requirements, and our available resources, we are no longer pursuing that Phase III trial. With the greatly reduced market size for the SC-I cells, we successfully obtained Orphan Product Designation.

      We have also conducted clinical feasibility trials to evaluate umbilical cord blood (CB) cells produced in the AastromReplicell System to improve recoveries of pediatric and adult patients requiring donor-derived (or allogeneic) stem cell transplants. Results of the pediatric transplants indicated that AastromReplicell System-produced cells were safe and well tolerated by the patients. Results from our adult cord blood trial may suggest that the AastromReplicell System could increase the quantity of cord blood cells available but do not

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Strategic Relationships

      In June 2003, we announced a strategic alliance with the Musculoskeletal Transplant Foundation (MTF) to jointly develop and commercialize innovative treatments for the regeneration of tissues such as bone and cartilage. The collaboration aligns us with the leading provider of allograft, or donor-derived tissue, materials (matrices) with a focus on forming a coordinated business and clinical approach for new products and treatments needed in orthopedic medicine. Under the terms of the alliance, Aastrom and MTF will coordinate and fund the development of products that are based on combinations of MTF’s allograft matrices and our Tissue Repair Cells (TRCs). The companies will both contribute in certain development and clinical trial expenses of these treatment approaches and products, and intend to adopt a coordinated promotion and marketing strategy for future products.

Manufacturing

      We have established relationships with third party manufacturers that are FDA registered as suppliers of medical products to manufacture various components of the AastromReplicell System.

      In March 2003, we signed a three-year master supply agreement with Astro Instrumentation, L.L.C., to manufacture our products, component parts, subassemblies and associated spare parts, used in the instrumentation platform of our AastromReplicell System. We retain all proprietary rights to our intellectual property that is utilized by Astro pursuant to this agreement.

      In March 1996, we entered into a License and Supply Agreement with Immunex Corporation, now a wholly owned subsidiary of Amgen Corporation, for an initial five-year term to purchase and resell certain cytokines and ancillary materials for use in conjunction with the AastromReplicell System. Subsequently, this license agreement was extended through March 2003. We are currently negotiating a new agreement with Amgen. In the event that Amgen elects to cease to supply to us cytokines and ancillary materials or is prevented from supplying such materials to us, there is no assurance that we could successfully manufacture the compounds ourselves or identify others that could manufacture these compounds to acceptable quality standards and costs, if at all. However, we are currently conducting pre-clinical research to evaluate the elimination of these components.

      In February 2004, we entered into a five-year agreement continuing Moll Industries as our supplier of Cell Cassettes. Under this agreement, Moll will perform commercial manufacturing and assembly of our Cell Cassette, the main single-use component of the AastromReplicell System. We retain all proprietary rights to our intellectual property that is utilized by Moll pursuant to this agreement.

      There can be no assurance that we will be able to continue our present arrangements with our suppliers, supplement existing relationships or establish new relationships or that we will be able to identify and obtain the ancillary materials that are necessary to develop our product candidates in the future. Our dependence upon third parties for the supply and manufacture of such items could adversely affect our ability to develop and deliver commercially feasible products on a timely and competitive basis. See “Business Risks.”

Patents and Proprietary Rights

      Our success depends in part on our ability, and the ability of our licensors, to obtain patent protection for our products and processes. We have exclusive rights to over 25 issued U.S. patents, and non-exclusive rights

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      The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that any patents based on pending patent applications or any future patent applications by us, or our licensors, will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to us, that any of the patents that have been or may be issued to us or our licensors will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held or licensed by us. Furthermore, there can be no assurance that others have not developed or will not develop similar products, duplicate any of our products or design around any patents that have been or may be issued to us or our licensors. Since patent applications in the United States are maintained in secrecy until shortly before patents issue, we also cannot be certain that others did not first file applications for inventions covered by our, and our licensors’ pending patent applications, nor can we be certain that we will not infringe any patents that may be issued to others on such applications.

      We rely on certain licenses granted by the University of Michigan and others for certain patent rights. If we breach such agreements or otherwise fail to comply with such agreements, or if such agreements expire or are otherwise terminated, we may lose our rights in such patents, which would have a material adverse affect on our business, financial condition and results of operations. See “Research and License Agreements.”

      We also rely on trade secrets and unpatentable know-how that we seek to protect, in part, by confidentiality agreements. It is our policy to require our employees, consultants, contractors, manufacturers, outside scientific collaborators and sponsored researchers, board of directors, technical review board and other advisors to execute confidentiality agreements upon the commencement of employment or consulting relationships with us. These agreements provide that all confidential information developed or made known to the individual during the course of the individual’s relationship with us is to be kept confidential and not disclosed to third parties except in specific limited circumstances. We also require signed confidentiality or material transfer agreements from any company that is to receive our confidential information. In the case of employees, consultants and contractors, the agreements generally provide that all inventions conceived by the individual while rendering services to us shall be assigned to us as the exclusive property of Aastrom. There can be no assurance, however, that these agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets or unpatentable know-how will not otherwise become known or be independently developed by competitors.

      Our success will also depend in part on our ability to develop commercially viable products without infringing the proprietary rights of others. We have not conducted freedom of use patent searches and no assurance can be given that patents do not exist or could not be filed which would have an adverse affect on our ability to market our products or maintain our competitive position with respect to our products. If our technology components, devices, designs, products, processes or other subject matter are claimed under other existing United States or foreign patents or are otherwise protected by third party proprietary rights, we may be subject to infringement actions. In such event, we may challenge the validity of such patents or other proprietary rights or we may be required to obtain licenses from such companies in order to develop, manufacture or market our products. There can be no assurances that we would be able to obtain such licenses or that such licenses, if available, could be obtained on commercially reasonable terms. Furthermore, the

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      Certain of our, and our licensors’, research has been or is being funded in part by the Department of Commerce and by a Small Business Innovation Research Grant obtained from the Department of Health and Human Services. As a result of such funding, the U.S. Government has certain rights in the technology developed with the funding. These rights include a non-exclusive, paid-up, worldwide license under such inventions for any governmental purpose. In addition, the government has the right to require us to grant an exclusive license under any of such inventions to a third party if the government determines that: (i) adequate steps have not been taken to commercialize such inventions, (ii) such action is necessary to meet public health or safety needs, or (iii) such action is necessary to meet requirements for public use under federal regulations. Additionally, under the federal Bayh Dole Act, a party which acquires an exclusive license for an invention that was partially funded by a federal research grant is subject to the following government rights: (i) products using the invention which are sold in the United States are to be manufactured substantially in the United States, unless a waiver is obtained; (ii) the government may force the granting of a license to a third party who will make and sell the needed product if the licensee does not pursue reasonable commercialization of a needed product using the invention; and (iii) the U.S. Government may use the invention for its own needs.

      In March 1992, we entered into a License Agreement with the University of Michigan, as contemplated by a Research Agreement executed in August 1989 relating to the ex vivo production of human cells. Pursuant to this License Agreement, as amended: (i) we acquired exclusive worldwide license rights to the patents and know-how for the production of blood cells and bone marrow cells as described in the University of Michigan’s research project or which resulted from certain further research conducted through December 1994; and (ii) we are obligated to pay to the University of Michigan a royalty equal to 2% of the net sales of products which are covered by the University of Michigan’s patents. Unless it is terminated earlier at our option, or due to a material breach by us, the License Agreement will continue in affect until the latest expiration date of the patents to which the License Agreement applies.

      In December 2002, we entered into an agreement with Corning Incorporated that granted them an exclusive sublicense relating to our cell transfection technology for increased efficiency in loading genetic material into cells. We own the intellectual property rights to methods, compositions and devices that increase the frequency and efficiency of depositing particles into cells to modify their genetic code. Under terms of the agreement, Corning’s Life Sciences business will utilize our unique technology to enhance the development of their molecular and cell culture applications in areas that are not competitive to our core business interest. We retain exclusive rights to the applications of the technologies involving cells for therapeutic applications, and received an upfront payment in addition to future royalties from Corning.

Government Regulation

      Our research and development activities and the manufacturing and marketing of our products are subject to the laws and regulations of governmental authorities in the United States and other countries in which our products will be marketed. Specifically, in the United States, the FDA, among other activities, regulates new product approvals to establish safety and efficacy of these products. Governments in other countries have similar requirements for testing and marketing. In the United States, in addition to meeting FDA regulations, we are also subject to other federal laws, such as the Occupational Safety and Health Act and the Environmental Protection Act, as well as certain state laws.

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      Our products are subject to regulation as biological products under the Public Health Service Act. Different regulatory requirements may apply to our products depending on how they are categorized by the FDA under these laws. The FDA has indicated that it intends to regulate the cells produced in the AastromReplicell System as a licensed biologic through the Center for Biologics Evaluation and Research. However, there can be no assurance that the FDA will ultimately regulate the AastromReplicell System in this manner.

      As current regulations exist, the FDA will require regulatory approval for certain human cellular or tissue based products, including cells produced in the AastromReplicell System, through a biologic license application (BLA).

      The FDA has published regulations which require registration of certain facilities, which may include our customers, and is in the process of publishing regulations for the manufacture or manipulation of human cellular or tissue based products which may impact our customers. We believe that the fixed validated process in a sterile disposable provided by our products will assist our customers in meeting these requirements, but the regulations may change prior to final release.

      Approval of new biological products is a lengthy procedure leading from development of a new product through pre-clinical and clinical testing. This process takes a number of years and the expenditure of significant resources. There can be no assurance that Aastrom’s product candidates will ultimately receive regulatory approval.

      Regardless of how our product candidates are regulated, the Federal Food, Drug, and Cosmetic Act and other Federal statutes and regulations govern or influence the research, testing, manufacture, safety, labeling, storage, record-keeping, approval, distribution, use, reporting, advertising and promotion of such products. Noncompliance with applicable requirements can result in civil penalties, recall, injunction or seizure of products, refusal of the government to approve or clear product approval applications or to allow us to enter into government supply contracts, withdrawal of previously approved applications and criminal prosecution.

      In order to obtain FDA approval of a new medical product, sponsors must generally submit proof of safety and efficacy. In some cases, such proof entails extensive pre-clinical and clinical laboratory tests. The testing, preparation of necessary applications and processing of those applications by the FDA is expensive and may take several years to complete. There can be no assurance that the FDA will act favorably or in a timely manner in reviewing submitted applications, and we may encounter significant difficulties or costs in our efforts to obtain FDA approvals, in turn, which could delay or preclude us from marketing any products we may develop. The FDA may also require post-marketing testing and surveillance of approved products, or place other conditions on the approvals. These requirements could cause it to be more difficult or expensive to sell the products, and could therefore restrict the commercial applications of such products. Product approvals may be withdrawn if compliance with applicable regulations are not maintained or if problems occur following initial marketing. For patented technologies, delays imposed by the governmental approval process may materially reduce the period during which we will have the exclusive right to exploit such technologies.

      If human clinical trials of a proposed medical product are required, the manufacturer or distributor of the product will have to file an Investigational Device Exemption (IDE) or Investigational New Drug (IND) submission with the FDA prior to commencing human clinical trials. The submission must be supported by data, typically including the results of pre-clinical and laboratory testing. Following submission of the IDE or IND, the FDA has 30 days to review the application and raise safety and other clinical trial issues. If we are not notified of objections within that period, clinical trials may be initiated, and human clinical trials may commence at a specified number of investigational sites with the number of patients approved by the FDA. We have submitted several IDEs and INDs for the AastromReplicell System, and have conducted clinical studies under these IDEs and INDs.

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      We believe that the cells produced in the AastromReplicell System will be regulated by the FDA as a licensed biologic, although there can be no assurance that the FDA will not choose to regulate this product in a different manner. The FDA categorizes human cell or tissue based products as either minimally manipulated or more than minimally manipulated, and has proposed that more than minimally manipulated products be regulated through a “tiered approach intended to regulate human cellular and tissue based products only to the extent necessary to protect public health.” For products which may be regulated as biologics, the FDA requires: (i) pre-clinical laboratory and animal testing; (ii) submission to the FDA of an IND or IDE application which must be effective prior to the initiation of human clinical studies; (iii) adequate and well-controlled clinical trials to establish the safety and efficacy of the product for its intended use; (iv) submission to the FDA of a biologic license application (BLA); and (v) review and approval of the BLA as well as inspections of the manufacturing facility by the FDA prior to commercial marketing of the product.

      Pre-clinical testing covers laboratory evaluation of product chemistry and formulation as well as animal studies to assess the safety and efficacy of the product. The results of these tests are submitted to the FDA as part of the IND. Following the submission of an IND, the FDA has 30 days to review the application and raise safety and other clinical trial issues. If we are not notified of objections within that 30-day period, clinical trials may be initiated. Clinical trials are typically conducted in three sequential phases. Phase I represents the initial administration of the drug or biologic to a small group of humans, either healthy volunteers or patients, to test for safety and other relevant factors. Phase II involves studies in a small number of patients to assess the efficacy of the product, to ascertain dose tolerance and the optimal dose range and to gather additional data relating to safety and potential adverse affects. Once an investigational drug is found to have some efficacy and an acceptable safety profile in the targeted patient population, multi-center Phase III studies are initiated to establish safety and efficacy in an expanded patient population and multiple clinical study sites. The FDA reviews both the clinical plans and the results of the trials and may request us to discontinue the trials at any time if there are significant safety issues.

      The results of the pre-clinical tests and clinical trials are submitted to the FDA in the form of a BLA for marketing approval. The testing and approval process is likely to require substantial time and effort and there can be no assurance that any approval will be granted on a timely basis, if at all. Additional animal studies or clinical trials may be requested during the FDA review period that may delay marketing approval. After FDA approval for the initial indications, further clinical trials may be necessary to gain approval for the use of the product for additional indications. The FDA requires that adverse affects be reported to the FDA and may also require post-marketing testing to monitor for adverse affects, which can involve significant expense.

      Under current requirements, facilities manufacturing biological products must be licensed. To accomplish this, a BLA must be filed with the FDA. In addition to the pre-clinical and clinical tests, the BLA includes a description of the facilities, equipment and personnel involved in the manufacturing process. An establishment license is granted on the basis of inspections of the applicant’s facilities in which the primary focus is on compliance with GMPs and the ability to consistently manufacture the product in the facility in accordance with the BLA. If the FDA finds the inspection unsatisfactory, it may decline to approve the BLA, resulting in a delay in production of products.

      As part of the approval process for human biological products, each manufacturing facility must be registered and inspected by the FDA prior to marketing approval. In addition, state agency inspections and approvals may also be required for a biological product to be shipped out of state.

      The AastromReplicell System instruments and disposables are currently being regulated in Europe as a Class I Sterile, Class IIb or Class III medical device, under the authority of the Medical Device Directive (MDD) implemented by EU member countries. These classifications apply to medical laboratory equipment and supplies including, among other products, many devices that are used for the collection and processing of blood for patient therapy. Certain ancillary products (e.g., biological reagents) used as part of the AastromReplicell System are treated as Class III medical devices.

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      The MDD vests the authority to permit affixing of the CE Mark with various Notified Bodies. These are private and state organizations which operate under license from the Competent Authority of the member states within the EU to certify that appropriate quality assurance standards and compliance procedures are followed by developers and manufacturers of medical device products or, alternatively, that a manufactured medical product meets a more limited set of requirements. Notified Bodies are also given the responsibility for determination of the appropriate standards to apply to a medical product. Receipt of permission to affix the CE Mark enables a company to sell a medical device in all EU member countries. Other registration requirements may also need to be satisfied in certain countries.

      We have received permission from our Notified Body (The British Standards Institute) to affix the CE Mark to the AastromReplicell System instrumentation and components for the SC-I kit, CB-I kit, DC-I kit, DCV-I kit and DCV-II kit. This has allowed us to market these products in the EU. There can be no assurance that the AastromReplicell System will continue to be regulated under its current status, any change in which would affect our ability to sell the product and adversely affect our business, financial condition and results of operations.

      New directives (laws) have recently become effective in the EU that may affect the manufacturing of cell products and clinical trials. These changes have delayed or in some cases temporarily halted dendritic cell clinical trials in the EU, which has reduced the number of customer opportunities and affected our progress in our Cell Production Products business. The recent changes to the European Union Medicinal Products Prime Directive shifted patient-derived cells to the medicinal products category. These new laws may delay some of our current planned clinical trials in the EU.

Competitive Environment

      The biotechnology and medical device industries are characterized by rapidly evolving technology and intense competition. Aastrom’s competitors include major multinational medical device companies, pharmaceutical companies, specialty biotechnology companies and chemical and medical products companies operating in the fields of tissue engineering, tissue regeneration, orthopedics and in a small number of instances, cell-based therapies. Many of these companies are well-established and possess technical, research and development, financial, and sales and marketing resources significantly greater than Aastrom. In addition, many smaller biotech and specialty medical products companies have formed strategic collaborations, partnerships and other types of joint ventures with larger, well established industry competitors that afford these companies potential research and development and commercialization advantages in product areas currently being pursued by Aastrom. Academic institutions, governmental agencies and other public and private research organizations are also conducting and financing research activities which may produce products directly competitive to those being commercialized by Aastrom. Moreover, many of these competitors may be able to obtain patent protection, obtain FDA and other regulatory approvals and begin commercial sales of their products before Aastrom.

      Aastrom’s potential commercial products address a broad range of existing and emerging markets, in which cell-based therapy is a new and as of yet, unproven, commercial strategy. In a large part, Aastrom faces primary competition from existing devices and products. Some of Aastrom’s competitors in orthopedic device and tissue engineered orthopedic applications have longer operating histories and substantially greater resources. These include Stryker Corp., Medtronic, Wright Medical, Smith & Nephew, Biomet, Osteotech, J&J/ DePuy, Zimmer and Synthes/ Mathys Medical. Other well-established competitors, such as CONMED, Arthrex and Implex Corporation compete in orthopedics with a variety of other tissue substitution products. A number of other companies have developed tissue-derived products for these markets, including Regeneration Technologies, Allosource, Lifecell Corporation, NovaBone, IsoTis Orthobiologics, Co.don and OrthoVita.

      In the general area of cell-based therapies, including orthopedics and other tissue regeneration applications, Aastrom competes with a variety of companies, most of whom are specialty medical products or biotechnology companies. Some of these, such as Genzyme Corporation and Fidia SA are well-established and have substantial technical and financial resources compared to Aastrom. However, as cell-based products are only just emerging as viable medical therapies, many of Aastrom’s direct competitors are smaller

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      Domestic product sales and rentals for the fiscal years ended June 30, 2002, 2003 and 2004 were $0, $0 and $10,000, respectively. Foreign product sales and rentals for the fiscal years ended June 30, 2002, 2003 and 2004 were $80,000, $314,000 and $39,000, respectively.

General

      We cannot project when we will generate positive cash flows from our consolidated operations. In the next several years, we expect that our revenue sources will consist of modest sales at irregular intervals from our CPP business to academic and commercial research centers, grant revenue, research funding and licensing fees from potential future corporate collaborators, and potentially the sale of TRCs in certain non-U.S. countries. To date, we have financed our operations primarily through public and private sales of our equity securities. As a development-stage company, we have never been profitable and do not anticipate having net income unless and until significant product sales commence. Achieving this objective will require significant additional funding. Our ability to achieve profitability on a sustained basis, if at all, or to obtain the required funding to achieve our operating objectives, or complete additional corporate partnering transactions is subject to a number of risks and uncertainties. Please see the section entitled “Business Risks”.

Employees

      As of August 31, 2004, we employed approximately 50 individuals on a full time equivalent basis. A significant number of our management and professional employees have had prior experience with pharmaceutical, biotechnology or medical product companies. None of our employees are covered by collective bargaining agreements, and management considers relations with our employees to be good.

Executive Officers of Aastrom

      Our executive officers, and their respective ages as of August 31, 2004, are as follows:

      R. Douglas Armstrong, Ph.D. joined Aastrom in June 1991 as its President and Chief Executive Officer, and as a Director. In 1999, Dr. Armstrong was elected Chairman of Aastrom’s Board of Directors. In July 2004, the duties and responsibilities of President were transferred to the Company’s new Chief Operating Officer, allowing Dr. Armstrong, as CEO, to increase focus on strategic activities and issues, investor relations, the Board of Directors, and Aastrom’s European subsidiary, Zellera AG, for which he is also Chairman of the Supervisory Board. From 1987 to 1991, Dr. Armstrong served as Executive Vice President and Trustee at the La Jolla Cancer Research Foundation (LJCRF), now named the Burnham Institute, a scientific research institute located in San Diego, CA. Prior to joining the Burnham Institute, Dr. Armstrong held various faculty and staff positions at the Yale University School of Medicine, University of California, San Francisco, LJCRF and the University of Michigan. Dr. Armstrong received a Bachelor’s of Arts degree in Chemistry from the University of Richmond in Richmond, VA, and completed his Doctorate in Pharmacology and Toxicology from the Medical College of Virginia. Additionally, Dr. Armstrong was a participant in the formation of Telios Pharmaceuticals, Inc., has served on the boards of both biotechnology and venture capital organizations, and currently serves as the Chairman of the Board for the Center for Cell Therapy.

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      James A. Cour joined Aastrom in July 2004 as its President and Chief Operating Officer. Prior to joining Aastrom Mr. Cour held executive level management positions with several companies, including Baxter International, Windsor VanGelder Limited and Cytomedix. Mr. Cour brings to Aastrom over twenty years of business success and accomplishments, ranging from strong expertise in operations and business development to strategic planning and international business. His broad range of experiences includes the management of major multinational healthcare operations, as well as a biotech/medical device company. Mr. Cour is skilled in the areas of medical products, biologic pharmaceuticals, business development, strategic alliances, analysis of new technologies and licensing. Mr. Cour received a Bachelor of Business Administration, with honors, from the University of Notre Dame, and an MBA from the University of Chicago, with concentrations in Marketing and International Business, with a specialization in Finance. He was also licensed as a Certified Public Accountant.

      Brian S. Hampson joined the Company in July 1993 as Director, Product Engineering and became Vice President Product Development in June 2000. He has been a principal leader in the development and engineering of the AastromReplicell Cell Production System. Previously, Mr. Hampson served as Manager, In Vitro Systems at Charles River Laboratories and held other positions after joining that company in January 1986. While at Charles River, he managed a number of programs to develop and commercialize novel bioreactor systems to support large-scale cell culture and biomolecule production. Prior to that, Mr. Hampson held several engineering positions at Corning Incorporated from September 1979 to January 1986, including assignments with KC Biological, a wholly owned subsidiary of Corning at the time. Mr. Hampson received his Bachelor of Science and Master of Engineering degrees in Electrical Engineering from Cornell University.

      Alan M. Wright joined Aastrom in September 2000 as a member of the Board of Directors until August 2002 when he joined the Company’s management team as Senior Vice President Administrative and Financial Operations and Chief Financial Officer. From 1991 to 2002, Mr. Wright held several executive positions at CMS Energy and its principal subsidiary, Consumers Energy, most recently as its Executive Vice President, Chief Financial Officer and Chief Administrative Officer, where he was responsible for raising $17 billion in capital during his tenure. Prior to joining CMS Energy, Mr. Wright held various financial management positions at Entergy Corporation, including Vice President of Finance. He served on the Finance Committee and the Finance and Regulation Executive Advisory Committee of the Edison Electric Institute (EEI), the Conference Board Council of CFOs, the Committee on Corporate Reporting of the Financial Executives Institute, and on Jenkins’ Special Committee to the Financial Accounting Standards Board. Mr. Wright earned a Bachelor of Science degree in Economics from Cornell University under a General Motors national scholarship. He has also completed Stanford University’s Executive Program, the EEI Executive Leadership Program and post-graduate studies in Accounting at the University of West Florida. In addition, Mr. Wright serves on the Board of Directors of Ensure Technologies, a privately held company.

Available Information

      Additional information about Aastrom is contained at our website, www.aastrom.com. Information on our website is not incorporated by reference into this report.

      We lease approximately 23,700 square feet of office and research and development space in Ann Arbor, Michigan under a lease agreement expiring in December 2004. We are currently negotiating an extension to our current lease and expect to complete this negotiation prior to its expiration. We believe that our facilities are adequate for our current needs. Additional facilities may be required to support expansion for research and development abilities or to assume manufacturing operations that are currently fulfilled through contract manufacturing relationships. We also lease office space in Berlin, Germany for our European Operations, Zellera AG.

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      We are not currently party to any material legal proceedings, although from time to time we may become involved in disputes in connection with the operation of our business.

      None

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PART II

      Beginning on February 4, 1997 our common stock was quoted on the Nasdaq National Market under the symbol “ASTM”. Since June 11, 2002, our common stock has been quoted on the Nasdaq SmallCap Market under the symbol “ASTM”. The following table sets forth the high and low closing prices per share of common stock as reported on the Nasdaq SmallCap Market:

Price Range of Common Stock

      As of August 31, 2004, there were approximately 594 holders of record of the common stock. We have never paid any cash dividends on our common stock and we do not anticipate paying such cash dividends in the foreseeable future. We currently anticipate that we will retain all future earnings, if any, for use in the development of our business.

      The following table sets forth information as of June 30, 2004 with respect to compensation plans (including individual compensation arrangements) under which equity securities are authorized for issuances:

(1)	Includes shares issuable under the 2001 Stock Option Plan and the 1996 Employee Stock Purchase Plan.

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